Overview of the Hong Kong Law Reform Commission Sub-committee’s Consultation Paper on Outcome Related Fee Structures for Arbitration

In October 2019, the Hong Kong Law Reform Commission established a Sub-committee on Outcome Related Fee Structures for Arbitration (the “Sub-committee”) to “review the current position relating to outcome related fee structures for arbitration, to consider whether reform is needed to the relevant law and regulatory framework and, if so, to make such recommendations for reform as appropriate.”

On 17 December 2020, the Sub-committee published its Consultation Paper on Outcome Related Fee Structures for Arbitration (“Consultation Paper”). The Sub-committee unanimously proposed that the law in Hong Kong should be amended to permit lawyers to use outcome related fee structures (“ORFSs”) for arbitration taking place in and outside Hong Kong. It also made recommendations on the operation of individual regimes relating to ORFSs. These recommendations represent the Sub-committee’s preliminary views and are presented for consideration by interested parties. The consultation period closes on 16 March 2021.

What Are ORFSs?

For the purposes of the Consultation Paper, an ORFS is an agreement between a lawyer and client, whereby the lawyer receives a financial benefit if the case is won. It includes several types of agreements, namely, conditional fee agreements (“CFAs”), damages-based agreements (“DBAs”) and hybrid damages-based agreements (“Hybrid DBAs”).

There are two forms of CFA. One form is a “no win, no fee” arrangement where the lawyer charges no fee during the course of the proceedings and is paid his or her usual fee plus an uplift if the client’s case succeeds. Another form is a “no win, low fee” arrangement where the lawyer charges at the usual rate or, more likely, at a discounted rate during the course of the proceedings, plus a success fee if the client’s case succeeds. For these two forms of arrangements, the success fee refers to an additional fee that the client agrees to pay the lawyer only upon the success of the case. It can be an agreed flat fee, or calculated as a percentage “uplift” on the fees charged during the course of the proceedings.

A DBA is another form of “no win, no fee” arrangement. If the client’s case is unsuccessful, the lawyer charges no fee. In the event of success, under a DBA, the lawyers’ fee is calculated by reference to the outcome of the proceedings, for example as a percentage of the amount awarded or recovered (“DBA Payment”).

A Hybrid DBA is a form of “no win, low fee” arrangement. The lawyer charges a fee for the legal services rendered (typically at a discounted rate) and, in the event of success, the DBA Payment.

Why Should ORFSs Be Permitted in Hong Kong?

At present, lawyers in Hong Kong are prohibited from charging outcome related fee in arbitration. By contrast, with the exception of Singapore, all major arbitral seats (these include England and Wales, Mainland China, Australia, the United States of America, France, Sweden, Switzerland and South Korea) permit some form of ORFS for arbitration. In October 2019, Singapore also completed a public consultation to introduce a framework for conditional fee agreements in relation to international and domestic arbitration proceedings and is now awaiting the outcome of that consultation. Evidence shows that there is rising client demand for alternative pricing and funding options, not only from impecunious clients seeking to fund meritorious claims, but also from clients looking to take some (or all) of the costs of arbitration off their balance sheet. These clients are generally free to seat their arbitrations anywhere in the world. If Hong Kong continues to prevent its lawyers from sharing that risk through ORFSs, it is likely that clients will choose to arbitrate elsewhere.

The Sub-committee considers that permitting ORFSs is essential to Hong Kong’s continued status as one of the world’s leading centres for arbitration services, and will enable Hong Kong to compete on an even playing field with other popular arbitral seats which allow some form of ORFSs. Given the continuing rise in arbitrations seated in Hong Kong involving Mainland Chinese parties, including claims arising out of the Belt and Road Initiative, it is more important than ever for lawyers in Hong Kong to be able to fund cases on the same, or similar, bases to lawyers from other jurisdictions where ORFSs are permitted. This is particularly so in the context of arbitration, where parties are, on the whole, commercial entities or business people familiar with negotiating commercial terms and related pricing for those services.

The Sub-Committee’s Consultation Paper

Overview

The Consultation Paper sets out a summary of the relevant law in Hong Kong and in nine jurisdictions where arbitration commonly takes place, including Singapore, England and Wales, Australia, Mainland China, USA, and some civil law jurisdictions, such as France, Sweden, Switzerland and South Korea. The Sub-committee has also made reference to the Law Reform Commission’s previous study of conditional fees for proceedings (including arbitration) between 2003 and 2007 as well as third party funding for arbitration between 2013 and 2016.

One of the major recommendations of the Consultation Paper is that the law in Hong Kong should be amended to permit lawyers to use ORFSs for arbitration taking place in and outside Hong Kong. The scope of the proposed reform in Hong Kong is currently limited to (a) arbitration proceedings and related court proceedings in Hong Kong, and (b) work done by lawyers in Hong Kong for arbitrations seated outside Hong Kong. The Sub-committee’s terms of reference do not include ORFSs for litigation and so the Sub-committee’s proposals do not cover the removal of the prohibition on the use of ORFSs for litigation proceedings before the Hong Kong courts.

Arguments For and Against ORFSs for Arbitration

Among other things, the Consultation Paper also discusses the arguments for and against ORFSs for arbitration. The major arguments for ORFSs for arbitration include (a) preserving and promoting Hong Kong’s competitiveness as a leading arbitration centre, (b) enhancing access to justice, (c) responding to client demand and providing pricing flexibility, (d) supporting freedom of contract, (e) weeding out weak claims and (f) enabling lawyers in Hong Kong to compete on an even playing field with other jurisdictions where ORFSs are allowed.

On the other hand, the Sub-committee has also considered in detail the arguments against ORFSs for arbitration, namely, (a) the risk of conflict of interest and unprofessional conduct, (b) increase in opportunistic and frivolous litigation, (c) excessive legal fees, (d) reliance on after-the-event / litigation insurance and (e) the risk of increase in satellite litigation.

After careful analysis, the Sub-committee has unanimously concluded that the arguments for introducing ORFSs for arbitration clearly outweigh the arguments against. Moreover, many of the perceived risks associated with ORFSs are historic or of no relevance to the current consultation, which is limited in scope to arbitration, and can in any event be managed by appropriate safeguards.

The Recommendations

Apart from recommending the removal of the prohibition on the use of ORFSs for arbitration for lawyers, the Sub-committee also makes recommendations on the operation of individual regimes relating to CFAs, DBAs and Hybrid DBAs. Some of the main recommendations are highlighted below.

Recommendation 2 - Non-recoverability of success fees from the unsuccessful party

Where a CFA is in place, the Sub-committee recommends in Recommendation 2, among other things, that any success fees agreed by the claimant with its lawyers should not be recoverable from the respondent (or losing party), following the current English provisions on recoverability of success fees.

Based on the Sub-committee’s study of overseas jurisdictions, the Sub-committee notes that, in England and Wales, the ability of a successful claimant to recover the success fee from the respondent led to an explosion of litigation. It would also be unfair if the losing respondent were responsible for these costs in circumstances where the respondent is not party to these contracts and has no control over the pricing structure agreed between the successful claimant and its lawyers. This is also consistent with the view of the Law Reform Commission’s Report on Conditional Fees in 2007.

Recommendation 3 – Capping the success fee

The Sub-committee recommends in Recommendation 3 that there should be a cap on the success fee for the CFA regime which is expressed as a percentage of normal or “benchmark” costs.

The Sub-committee’s study shows that other jurisdictions have put in place a cap on the success fee. In England and Wales, the success fee is capped at 100 percent of normal costs. In Australia, for contentious proceedings the success fee is subject to a lower cap of 25 percent (excluding disbursements) of the legal fees otherwise payable.

The Sub-committee notes that in many cases the success fee will be profit and accordingly invites proposals on what an appropriate cap should be, up to a maximum of 100 percent. The Sub-committee also invites proposals on whether barristers should be subject to the same, or a different, cap and, if different, what that cap should be, up to a maximum of 100 percent.

Recommendation 6 – Recovery of costs based on “Ontario model” v “Success fee model”

In England and Wales, the recovery of costs in a DBA context is currently based on the so-called “Ontario model”. Under the Ontario model, clients cannot recover the full DBA Payment from the losing opponent, if it is higher than the costs that would otherwise be recoverable. The client must pay any shortfall between recoverable costs and the DBA Payment. Conversely, as a result of the indemnity principle, if the DBA Payment is lower than the costs that would otherwise be recoverable, only that lower amount can be recovered.

One of the recommendations proposed by Professor Rachael Mulheron and Nicolas Bacon QC, who were invited by the UK Ministry of Justice to conduct an independent review of the existing Damages-Based Agreements Regulations 2013 in England and Wales, is to switch to the “Success fee model”. Under the Success fee model, costs recovered from the respondent are outside of, and additional to, the DBA Payment. The DBA Payment is thus treated as the success fee, which can be retained by the lawyer on top of the recoverable costs awarded.

The Sub-committee invites submissions on whether the Ontario model or the Success fee model should apply to DBAs. It is the Sub-committee’s preliminary view that the recommendation proposed by Professor Rachael Mulheron and Nicolas Bacon QC to move to a Success fee model should be followed.

Recommendation 7 – Capping the DBA Payment

The Sub-committee recommends in Recommendation 7 that there should be a cap on the part of the financial benefit obtained in respect of DBA payment for the DBA and Hybrid DBA regimes, which should be expressed as a percentage of the “financial benefit” or “compensation” received by the client.

The Sub-committee’s study shows that, in England and Wales, the current cap is 50 percent of the “financial benefit” or “compensation” received by the client, while a 30 percent cap of “the claim amount in a dispute stated in a contract for legal service” applies in Mainland China.

The Sub-committee is of the view that there is scope for capping the maximum DBA payment at less than the 50 percent cap currently adopted in England and Wales for commercial claims, particularly if the Success fee model is adopted, and that an appropriate range for consultation is 30-50 percent.

Recommendation 13 – Further consultation on safeguards as well as personal injury and other non-commercial claims

The Sub-committee invites submission on what specific safeguards should be addressed in the professional codes of conduct of the two legal professional bodies and subsidiary legislation. Another issue on which the Sub-committee invites comments is whether personal injury claims should be treated differently from other claims in arbitration and whether any additional category/categories of claim should be treated differently from other claims that are submitted to arbitration if ORFSs are introduced.

Conclusion

The Sub-committee welcomes views, comments and suggestions on any of the issues discussed in the Consultation Paper by the close of the Consultation Period on 16 March 2021.

Jurisdictions

Co-chair, Outcome Related Fee Structures for Arbitration Sub-committee of the Law Reform Commission of Hong Kong

Partner, Herbert Smith Freehills

Kathryn has over 15 years’ experience of advising clients on arbitration and litigation proceedings in Asia Pacific across a wide range of industries and locations, with particular strengths in private equity, financial services, M&A, and in China-related matters. Her arbitration skills and reputation in China matters are enhanced by her ability to speak and read Mandarin Chinese. Kathryn has an impressive profile in the Asian international arbitration market. She was a Council Member of the Hong Kong International Arbitration Centre (HKIAC) between 2008 and 2019.

Co-chair, Outcome Related Fee Structures for Arbitration Sub-committee of the Law Reform Commission of Hong Kong

Foreign Legal Consultant (England and Wales)/ Professional Support Consultant, Herbert Smith Freehills

Briana has over 15 years’ experience in international arbitration, first as counsel and now as a foreign legal consultant and professional support consultant in Herbert Smith Freehills’ Greater China international arbitration team. She is also an experienced Tribunal Secretary, and sits as arbitrator. Based in Hong Kong, she is a senior member of the Herbert Smith Freehills team and an expert in international arbitration law and procedure.